The present invention relates to options on securities which are bought and sold on regulated exchanges around the world. Ownership of a "call" option gives the purchaser the right, but not the obligation, to buy a particular security at an established price (the "strike price" or the "exercise price"). Ownership of a "put" option gives the purchaser the right, but not the obligation, to sell a particular security (called the underlying security) at the strike price. The sellers of both the put and the call are obligated to perform the transaction if demanded by the purchaser of the option. This performance is guaranteed by the posting of a performance bond (the "margin requirement"). In addition to the two types of options (put and call), there are two distinct classes of options (both puts and calls): the "American option" and the "European option." The purchaser of the American option may exercise the option (i.e., choose to buy/sell at the strike price) at any point prior to the expiration of the life of the option. The purchaser of the European option may exercise the option only at its expiration date. For either option type, if exercise is possible, the option is said to be "in-the-money" or "intrinsic," otherwise it is "out-of-the-money" or "extrinsic." The expiration dates of exchange-traded options are standardized and the same option contract may be bought or sold at any point prior to expiration. An investor who purchases an option (put or call) is said to "long" the option and holding a "long call" or "long put." An investor who sells an option (put or call) is said to "short" the option and holding a "short call" or "short put."
Options as a means of hedging risk are of increasing interest not just to speculators and small investors, but also to insurance and mortgage companies, banks, credit unions, farmers and other commodity producers such as mining companies, oil companies, and manufacturing companies whose revenue depends heavily upon the floating price of a commodity in the market place. Insurance companies can hedge against a change in the yield curve, or the cost of money over different time horizons. Banks and credit unions can protect themselves from unanticipated loan prepayments if interest rates fall precipitously. Commodity producers which have a significant investment and lead time from production to market can hedge against an unanticipated drop in prices. Manufacturers of all types, from electronics to cereals, can protect themselves from an increase in the price of a key production items, such as gold or oats.
In the current marketplace for risk management, producers have the choice of two risky and inferior alternatives. The first is a margin or futures position which will offset not only the damage of unanticipated price changes, but will also offset the rewards if prices move in their favor. It is also only available at the current security price. While the point-for-point movement does allow an almost zero-sum game, it has the unpleasant side effect of the monetary risk not being limited to the original premium payment and commission. Given a sustained movement in price in a direction which would normally be considered favorable, the individual or company is forced to replenish funds in the futures or margin account or have the position closed, forcing unanticipated cash flow pressures or the loss of the risk insurance. The second alternative is an option position which, though the risk is limited to the premium and commission, is of limited lifespan. If prices are stable over the period against which the individual or company wishes to hedge, they are forced to continually pay additional monies to insure against loss, or face the loss of the risk insurance. Additionally, because ephemeral, or short-lived, options are a contingent claim, the option may not move point-for-point with the underlying security, resulting in a loss that is not insured. This invention maintains the advantages of both alternatives without the disadvantages. An expirationless American option moves approximately point-for-point within the relevant range, but need not be used until needed, allowing the purchaser to hedge risk over an extended period of time. Furthermore, it has the property of limited liability, so that the maximum loss incurred (if any) is the option premium and commission. Because it is available at prices other than the current security price, it is possible to maximally hedge against loss while maintaining most of the positive effect from a beneficial move in the price of the underlying security.
The calculation of the price of the option must be efficient with respect to prices within the market and minimize the probability of an arbitrage (riskless) profit. This price must be based on the conditions under which it would be exercised or sold, and provide for an efficient market for these securities.
For example, current information on margin requirements for all securities and markets is available on a daily basis from the respective exchange. It is also possible to receive current quotations on the price of a security through a variety of sources, e.g., from cable TV equipped with special decoders to satellite transmissions. It is expected that the available exercise prices would be established by the exchange and would match the exercise prices for ephemeral options that already are traded; however, an expirationless American option can be sold at any rational price. Clearly, given the constant change in the current prices of securities, the vast number of applicable securities for expirationless American options, the differing margin requirements demanded by the exchanges as well as the record keeping requirements, prompt information and calculation of correct prices and portfolio tracking is only available through computerization.